Banking

Seven European banks fail stress tests

Lenders had shortfall of around $4.5 billion under toughest test

By

SimonKennedy

LONDON (MarketWatch) -- Seven out of 91 European banks failed the region's long-awaited stress tests and may need to raise more than 3.5 billion euros ($4.5 billion) of additional capital, the Committee of European Banking Supervisors said Friday.

Five of the lenders that failed were unlisted Spanish savings banks, with Germany's nationalized Hypo Real Estate and Greece's ATEBank
ABGEF
also unable to maintain a Tier 1 capital ratio of more than 6% under the most severe scenario tested. See story on the five Spanish banks that failed.

All the other German lenders including the troubled landesbanks passed the test, along with all of Europe's big listed banks.

The tests were intended to reassure investors and help ease pressure in bank funding markets as the global financial crisis -- and in particular worries about sovereign debt in many European countries -- undermined confidence in the banking system. Read "Time will tell for Europe's stress tests."

The total losses of all the lenders tested would have been €566 billion under the most severe scenario in the tests, CEBS said in a statement. But those banks that failed still only had a €3.5 billion capital shortfall, it added.

CEBS said national authorities are in contact with the seven banks to assess the implications of the tests, particularly in terms of recapitalization needs. Banks that only just passed the test will have to make their own call on capital needs.

"On the face of it, the results of the EU bank stress tests would seem to be fairly positive, but worries that the tests were not demanding enough will persist," said Jennifer McKeown, senior European economist at Capital Economics, in a note.

Two scenarios

Officials used two sets of macroeconomic scenarios -- benchmark and adverse, in order to stress test the credit risk and simulate profit and losses.

Within the adverse scenario, the exercise also envisages a "sovereign risk shock," reflecting adverse conditions in financial markets.

The benchmark macroeconomic scenario assumes a mild recovery from the severe downturn of 2008-2009, whereas the adverse scenario assumes a "double-dip" recession.

The details came out after European markets had closed, but the euro came under pressure earlier in the session after details on the methodology used by regulators began to appear. See full story on stress-test methodology.

The U.S. listed shares of most European banks were also mostly higher Friday, with Royal Bank of Scotland
RBS, +0.42%
(RBS) up 4%, Deutsche Bank (DBK)
DB, -0.12%
up 0.5% and Bank of Ireland
IRE, -0.59%
gaining 3.3%.

Sovereign debt

In particular, analysts had criticized the decision to model a sharp drop in the price of sovereign debt, but to assume that no country would actually default, which means banks only had to record losses on sovereign bonds they held for trading purposes.

Giovanni Carosio, chair of the Committee of European Banking Supervisors, hit back at criticism that the tests were too weak, saying the assumptions were tougher than those used in the U.S. stress tests last year.

"Not only is the stress that we applied to the banks a severe one, it also does imply a very significant amount of losses," he said in a press conference

"What really explains the result is essentially the fact that the banks start from very high levels of capital ratios," he added.

CEBS also defended the decision not to assume any sovereign default, saying the €750 billion support package put together by the EU and the International Monetary Fund effectively ruled out a default.

Gary Jenkins, head of fixed-income research at Evolution Securities said the U.S. tests were a different scenario and didn't have to consider the possibility of sovereign default.

"Whilst the stress tests do not take into account the worst case scenario of multiple sovereign failures, we know what the impact of such a disastrous backdrop would be anyway; that is a complete collapse of the western world's financial system," Jenkins said.

"The EU governments will not allow banks to actually fail in the market, thus it is the sovereign bond market that is key in the short term, because there is not anyone who can bail out the governments," he added.

Credit Suisse analyst Guillaume Tiberghien also pointed out that the European tests come at a different point in the downturn.

He calculated that European banks have already raised more than €220 billion of capital in the last 15 to 18 months, through a combination of bailouts, capital issuance and retained earnings.

He said that compares favorably to the $75 billion raised following the U.S. stress tests and that a "relatively favorable" outcome in Europe was therefore to be expected.

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